Small Business Owners: Do You Know Your Retirement Plan Options?
Are you an owner or employee of one of America’s 28 million small businesses? Are you a stay-at-home mom that has a “side hustle”? Do you work full time but have a “side gig”? With 99.7% of all business in the United States considered as small businesses (those with less than 500 employees), it is likely you fall into the “small business” category!
Of those reported small businesses, about 75% were single person operations. Between 2007 and 2016, the number of women owned businesses rose by 45%, which is five times faster than the national average. So that means that the vast majority of Americans are depending on their small business to provide an employer-sponsored retirement plan. Most people are familiar with a 401k or an IRA, but what other options are out there that may be simpler to run for the small business owner?
And why should employers care about having a retirement plan as a part of their benefits package? Two answers.
- One is a bit selfish; employers also have to worry about themselves! They need to save for their own retirement. By offering a retirement plan, they can put money away and receive tax benefits as well.
- Employee retention – employees want to work for a company that cares and helps them plan for the future. Employer-sponsored retirement plans are a great (and sometimes easy way) to keep the best employees.
So, what are some options for a small business?
SIMPLE IRA
With a name like that, it sure better be simple for an employer to run and it truly is. There are restrictions on what kind of employers can run this plan; they must have less than 100 employees that make $5,000/year. So that leaves lots of small business or start-ups eligible to use this kind of plan. The costs of establishing this plan are very low, as you just need to open a SIMPLE IRA account with your preferred custodian and assist each eligible employee in doing the same. Employees can contribute up to $12,500 (with an extra $3k/year if you are over 50). The employer then has the choice of doing a 2% of compensation non-elective contribution or a 3% match on an annual basis. The contribution limits are lower than other plans, but again this is easy to set up and maintain and fairly low contribution limits required by the employer.
SEP IRA
This option offers low set up costs but has higher contribution limits. A SEP does not allow employee contributions; everything that is contributed to a SEP is directly from the employer. This plan allows contributions up to $55,000 into the plan or up to 25% of compensation – whichever is less. A SEP requires that the employer makes contributions proportional among all employees – which means the same percentage of compensation, needs to be contributed to each employee’s account. So, with an employer making $200,000 per year and an employee making $50,000 per year, and a 10% contribution percentage for the year, the owner would put $20,000 into their own account and $5,000 into the employee’s account. This is an easy way to skew contributions towards the owner with low set up costs.
Individual 401(k)
This is very similar to a 401(k) that you would see with a large employer plan, however, you are both the employee and the employer. This plan only works if you are a one person shop or if you and your spouse work together. If you start adding additional employees, it adds significantly to the regulations and reporting required. If it is just you or you and your spouse, an Individual 401(k) could be a great fit. You can usually save more than available within the plans above, saving to both Roth (post-tax) and Traditional (pre-tax) monies from the employee side, and more pre-tax monies from the employer side. In 2018, you can save up to $18,500 (+6k if you are 50 or older) on the employee side, and up to $36,500 on the employer side.*
It doesn’t matter if a small business is your full time job or you are working a few hours here and there as a stay-at-home mom, there can be great benefits for you and your business with an established retirement plan. As a small business owner, you already have a full plate. Utilizing the Simple IRA, SEP IRA, or Individual 401(k) to start saving for retirement is an efficient way to realize tax savings and help retain employees.
*Limitation subject to change
Sources: Forbes, Women@Forbes. (2017, November). Seven Women-Owned Businesses To Support On Small Business Saturday [Press release]. Retrieved from https://www.forbes.com/sites/ruthieackerman/2017/11/23/seven-women-owned-businesses-to-support-on-small-business-saturday/#4d2763d3155d; Frequently Asked Questions [Publication]. SBA’s Office of Advocacy. Retrieved from: sba.gov/sites/default/files/FAQ_Sept_2012.pdf
This is intended for informational purposes only and should not be construed as investment or financial advice. Please consult your investment and financial professional(s) regarding your specific circumstances.
Sarah E. McGinniss
Financial Advisor / Market Manager
CFP®, CRPS®, ABFP